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THE POWER OF CIRCUMSTANCE

This note was originally published at 8am on January 13, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“If we had 8% unemployment, Keynes would be back.  We must remember that economists are not necessarily the creatures of great thought but of circumstance.  Keynes would not have written ‘The General Theory’ except in the Great Depression.”

-John Kenneth Galbraith, 1999

 

Today’s quote of the day is typical of Galbraith; he expressed his views with a masterful economy of language.   Ten years after Galbraith made his prediction that Keynes would be back in vogue if unemployment reached 8%, his prophecy came true.  Robert Skidelsky began writing “Keynes: Return of the Master” – on January 1st, 1999 – as unemployment was just under 8% and trending higher.  The Wall Street Journal also devoted a full-page spread to Keynes a week after Skidelsky put pen to paper. 

 

It’s difficult to understand the motivations of academic economists.  The measure of success for an economist, some might argue, is whether or not one’s theory stands the test of time and remains part of future policy debates.  The difficulty with this, as Skidelsky highlights, is that circumstances may permit your ideas to be heard outside of academia but they will almost certainly demand that theories will, as policies, be applied in a vulgarized form.  The discrediting of economists in recent times has prompted many public figures to disavow all ties with the profession; Tim Geithner is just one example.

 

Despite the provocative title of his aforementioned book, Skidelsky is realistic and honest about the role of circumstance in the ascension of Keynes and others to the throne of economics that some would place them on, stating that “just as Keynes succeeded politically because unemployment was the problem of the 1930s, Friedman succeeded politically because inflation was the problem of the 1970s.”  The rise of Barrack Obama and, perhaps, the ever-perseverant Mitt Romney are also permitted more by the fickle preferences of their time than the genius of their ideas.  Thankfully, politicians and the policies they implement are answerable to voters.  One long term positive emerging in the United States is what could be called the bottoming process of political participation in this country.  Obama’s engagement of the youth vote through social media was a political revelation of a scale not seen since Reagan went public with his appeal for voters to contact their state representatives to support Federal Tax Reduction Legislation in July 1981.  The Great Communicator understood the value of engendering a feeling of inclusivity among the electorate and he warned Congress of the importance of public opinion, also in 1981, by quoting Teddy Roosevelt’s message to Congress 80 years prior, “The American people are slow to wrath but when their wrath is once kindled, it burns like a consuming flame.”  The aftermath of the Great Recession has bred a new strain of voter: young, confused and dissatisfied with their vision of the future.  The internet is greasing the wheel of mobilization as circumstance drives voters to wonder what factors are behind the country’s predicaments and how they can be changed.

 

A Gallup poll conducted in July 2011 posed the following question to Americans: What do you think is the most important problem facing this country today?  The top three responses were “economy in general”, “jobs”, and “federal debt/deficit”, making up 31%, 27%, and 16% of the responses, respectively.  While Obama has recorded some significant coups in terms of the War on Terror and has taken pride in health care legislation passed on his watch, what the vast majority of Americans want is the economy to be back on track.  The longer the “Jobless Recovery” continues, the less relevant other topics become.

 

We believe that a strong dollar is the first step to rejuvenating American confidence. 71% of GDP is consumption and a stronger dollar increases purchasing power.  GDP growth has strengthened sequentially as the greenback appreciated and we expect that to continue.  Politicians in Washington need to recognize the strong dollar and the impact it has had on the economy recently.  The short term impact for jobs has been unmistakably positive.

 

Our Chart of the Day highlights this point clearly.  The two meaningful positive moves in the US Dollar Index since 2009 have coincided with improvements in employment growth.  One of the many positives of democracy is that, in the end, the mandate is made clear.  The People’s directive to Washington, D.C. is to create jobs.  Economists that debate the optimal method by which to achieve this end are not incentivized to compromise.  There are neither direct consequences of their words nor any clock hurrying them through their thought processes.  Politicians are not being afforded such shelter from scrutiny.  To compromise is the most human of actions and, whether they like it or not, many political figures in Washington are going to be forced to do just that from now on.  The circumstances – and the People – demand it.

 

Have a great weekend,

Rory Green

 

THE POWER OF CIRCUMSTANCE - strong dollar

 

THE POWER OF CIRCUMSTANCE - VP 1 13



Playing Blind

“We can be blind to the obvious, and we are also blind to our blindness.”

-Daniel Kahneman

 

That’s one of what I expect to be many solid risk management quotes from the book I am currently reviewing, “Thinking, Fast and Slow” by behavioral psychologist/economist Daniel Kahneman (page 24).

 

Are we blind to the obvious? Are we blind to our own blindness? I think we should probably ask ourselves that question both as individuals and as leaders in our society each and every day.

 

Last night, Daryl Jones, David Bergerson, and I hosted a dinner with 10 Portfolio Managers in mid-town Manhattan. This wasn’t an “idea dinner” like the ones the Old Wall still tries to host where people push their books. This was a legitimate Global Macro debate.

 

Fully loaded with the political discussion (which even if you’re not political actually has to be had – which is sad, I know), after 3 hours I concluded that we are all Playing Blind to what could ultimately happen out there each and every day.

 

Iran, Europe, Qe3? Romney, China, Gold? Growth, Earnings, Levels?

 

It’s all out there. It’s all interconnected. And the only way to even begin to attempt to absorb it all is to have a repeatable risk management process that’s Multi-Factor and Multi-Duration. Embrace Uncertainty.

 

Back to the Global Macro Grind

 

What I didn’t expect this morning was waking up to another central planning rumor.

 

These central planners, like most Keynesians, fundamentally believe that they can temporarily arrest gravity. When their plans don’t work, they just make it a bigger plan.

 

How about a trillion?

 

That’s the IMF “rumor” this morning. Never mind contextualizing what a trillion dollars actually is or that any IMF sponsored trillion dollar package is implicitly backstopped by the United States of America’s tax payers – just think about it some more – think fast and slow - and watch the S&P futures whip around on this while you attempt to remain sane.

 

What are markets doing on that?

 

(hint, they are going up)

 

What do you do with that?

  1. You stay out of the way on the short EUR/USD position until it re-tests $1.31 (immediate-term TRADE resistance)
  2. You stay out of the way on the short German DAX position until it re-tests 6502 (long-term TAIL resistance)
  3. Your stay away from economists at the World Bank (another Washington based beauty) and their estimates

That 3rdpoint is more of a transition sentence to what is a Top 3 Most Read on Bloomberg today (next to Jerry Yang and Carnival Cruise lines): “World Bank Cuts Global Growth Estimates.” Gee, thanks for coming out guys.

 

Talk about the blind leading the blind – after looking for +3-4% US Growth (depending on when you asked them for a US GDP Growth estimate last year), the World Bank is cutting their US Growth estimate from 2.9% to 2.2% this morning.

 

At the same time, we’re taking our US Growth estimates up…

 

Rather than Playing Blind from a Growth and Inflation modeling perspective, we actually have our own models that actually work. They don’t work all of the time. But they worked in calling both turns - in both Growth and Inflation - in both 2008 and 2011.

 

The same models that had us turn bullish (versus consensus expectations) on Growth in early 2009, have us getting bullish, on the margin, on Growth in 2012.

 

Why?

  1. US Dollar Strength = Deflates The Inflation
  2. Deflating The Inflation = higher real (adjusted for inflation) Growth

I’m often blind to my own blindness. But I’m not blind to what our models are telling me. Rather than debate the obvious implied by a broken consensus source code, I’ll just call building a Washington Consensus out for what it is – it’s what group-thinkers do.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, US Dollar Index, and the SP500 are now $1, $110.10-$112.17, $1.26-1.29, $80.24-81.77, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Playing Blind - 1. EL EUR

 

Playing Blind - 1. VP Heute


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HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS

Credit Trends Improve in December

December monthly credit data released today showed ongoing credit quality improvement among the six big issuers. The average issuer saw delinquencies improve 11 bp in December, with 4 of the 6 issuers saw delinquencies decline by 10 basis points or more. Citigroup saw the largest sequential decrease in its delinquency rate, falling 17 bp to 3.11% On a 4Q vs. 3Q basis, all issuers improved except for Capital One, which posted a 2 bp increase in delinquencies. On the net charge-off front, the average issuer showed 21 bp of improvement in December with the 4Q vs 3Q improvement coming in at 35 bps, on average. Capital One was the only issuer to have net charge offs rise in 4Q vs. 3Q (by 15 bps).

 

The improvement in credit quality for the month of December is attributable to two factors. First, there was a significant denominator effect this quarter, the first in a long time. Second, the economy is providing a tailwind as jobless claims have been improving throughout 4Q11. Both of these factors could persist over the intermediate term.  

 

HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - TABLES  5  

 

HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - CCMT avg for top 6 issuers

 

 HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - All DQ

 

 HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - All NCO

 

 HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - AXP nco dqcy

 

 HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - BAC nco and dqcy

 

 HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - C nco and dqcy

 

 HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - JPM nco and dqcy

 

The charts below show our macro team's quantitative levels for the six major issuers. 


 HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - AXP macro chart

 

 HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - BAC macro chart 2

 

 HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - C macro chart

 

 HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - COF macro chart

 

 HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - DFS MACRO CHART

 

HEDGEYE CARD ROUND UP: DEC CREDIT IMPROVEMENT PART DENOMINATOR, PART CLAIMS  - JPM macro chart

 

Joshua Steiner, CFA

 

Allison Kaptur

 

Robert Belsky

 

Having trouble viewing the charts in this email?  Please click the link at the bottom of the note to view in your browser.  


China, With Context

Conclusion: As of now, the data is not particularly supportive for China to meaningfully ease monetary policy (and thereby reflating import demand) in the near term. Moreover, inflation expectations need to continue trending down for Chinese assets to keep working and we anticipate that will happen as King Dollar continues to weigh on commodity prices over the intermediate-term TREND.

 

Virtual Portfolio Positioning: Long Chinese equities (CAF); Closed our long position in Hong Kong equities (EWH) earlier today.

 

Rather than react to the mania of financial media headlines and 1-day price moves, we think intermediate-to-long-term investors would be much better suited to have a process by which to properly contextualize the latest deltas in Chinese growth/inflation/policy. Our updated thoughts on each are below:

 

Growth: China’s 4Q/DEC economic growth data came in better than bad, which is in-line with our view that Chinese growth is slowing at a slower rate and looks to bottom-out here in 1Q12:

  • 4Q11 Real GDP: +8.9% YoY vs. +9.1% prior vs. +8.7% Bloomberg Consensus; +8.9% is the slowest pace of growth since 2Q09 and well off the 1Q10 cycle-peak of +11.9%;
  • Retail Sales: +18.1% YoY in DEC vs. +17.3% prior;
  • Industrial Production: +12.8% YoY in DEC vs. +12.4% prior;
  • YTD Urban Fixed Assets Investment: +23.8% YoY in DEC vs. +24.5% prior;
  • M2 Money Supply: +13.6% YoY in DEC vs. +12.7% prior;
  • New Loan Growth: CNY640.5B MoM in DEC vs. CNY562.2B prior;
  • Manufacturing PMI: 50.3 in DEC vs. 49 prior;
  • Non-Manufacturing PMI: 56 in DEC vs. 49.7 prior;
  • Exports: +13.4% YoY in DEC vs. +13.8% prior;
  • Imports: +11.8% YoY in DEC vs. +22.1% prior; +11.8% is the slowest rate of growth since OCT ’09 and highlights Chinese demand (or lack thereof) for things not produced in China (i.e. raw materials); and
  • Trade Balance: +26.3% YoY in DEC vs. -36.5% prior.

 China, With Context - 1

 

Inflation: China’s DEC inflation data was dovish, on the margin, but still not supportive of a dramatic reversal in Chinese monetary policy from either an absolute or trend-line perspective:

  • CPI: +4.1% YoY in DEC vs. +4.2% prior; though +4.1% is a 15-month low growth rate, we’d be remiss to join consensus speculation on monetary policy in the context of random 15-month intervals… instead we should focus on the fact that Chinese CPI has been above-target (+4% YoY) every month since SEP ’10; on a MoM basis, CPI accelerated +0.3% in DEC vs. -0.2% prior; sequential gains in CPI are a headwind to monetary easing;
  • PPI: +1.7% YoY in DEC vs. +2.7% prior; a surprisingly coincident indicator for Chinese consumer-price inflation (we would expect it to be a leading indicator, but it is not); and
  • Manufacturing PMI Input Prices: 47.1 in DEC vs. 44.4 prior.

 China, With Context - 2

 

China, With Context - 3

 

Policy: Rather than interpret China’s latest batch of data as a leading indicator of what we hope China will do on the policy front (see: sell-side reaction below), we think it’s critical to focus on where China has been and where it wants to go with regards to policy. Before we do that, however, it’s important to highlight the consensus reaction to the latest Chinese economic data:

 

“Decelerating GDP growth will provide more room for policy makers to shift towards a pro-growth bias after an extended tightening cycle.”

-Jing Ulrich, Chairman of Global Markets for China at JPMorgan Chase & Co.

 

“Amid a slowdown of both domestic and external economies, the government will continue to roll out stimulus policies.”

-Sylvia Chiu, an economist at SinoPac Financial

 

“China has a lot of room to adjust policies to simulate growth or address any kind of weaknesses in the economy.”

-K.C. Chan, Hong Kong’s Financial Services Secretary

 

In that light, we find it critical to remember that Slowing Growth is all part of the plan for Chinese policymakers. Ma Jiantang, Head of China’s Bureau of National Statistics, said it best overnight:

 

“China is prepared for a slowdown in economic growth and a mild moderation is desirable.”

 

To that point, we must not forget that the current growth slowdown in China is one that is: a) over two years old; and b) well within the State Council’s stated goals. Since 1Q10, Chinese policymakers have been implementing various measures ranging from property tax trials, to reserve requirement/rate hikes in order to “curb real estate prices”. In light of this, we see no reason for Chinese policymakers to panic and suddenly reverse course on monetary policy.

 

In fact, slowing rates of Chinese economic growth in order to combat inflation has been their focus for nearly two full years and that is highlighted by their 2011-12 and 5yr outlooks for Chinese real GDP growth (8% in 2011-12; 7% per annum in the latest 5yr plan). For reference, full-year 2011 real GDP growth came in at +9.2% – a full 120bps above the State Council’s target!

 

The net of it all is that the case for China to ease monetary policy in the near term is not as strong as consensus would have you believe. While we think a reserve requirement cut may be in order to alleviate interbank liquidity ahead of the Lunar New Year holiday (starting 1/23), we don’t see a strong case for a meaningful easing of monetary policy in the near term. While an RRR cut would be in line with Premier Jiabao’s monetary policy “fine-tuning”, the data just does not support consensus speculation for a dramatic reversal in China’s monetary policy stance.

 

China, With Context - 4

 

In fact, looking at the day-over-day moves in Chinese 1yr O/S interest rate swaps (+11bps), the data (DEC in particular) is actually more hawkish, on the margin, than dovish. Intuitively, that makes sense, given where the current level of Chinese economic growth fits within the State Council’s strategy and our call for Chinese growth to Slow at a Slower Rate.

 

Do we expect China to embark on a rate cutting cycle over the intermediate term? Most certainly, given that both market prices and our fundamental models point to a dovish outlook for Chinese monetary policy. That would, however, likely coincide with lower prices across the commodity complex, given that QE2-fueled commodity reflation was one of the primary drivers of hawkish Chinese CPI and PPI readings. For reference, the CRB All-Commodities Index is still up +16.2% since Jackson Hole 2010.

 

China, With Context - 6

 

China, With Context - 5

 

All told, it takes a China bull (’09; late ‘11) and China bear (’10; early ‘11) to know one, and, more importantly, to know where to poke for holes in the consensus bull/bear theses on China. We continue to question the sustainability of Chinese equities/corporate credit working at the same time as commodities.  To the former point, Chinese equities are up +7% from a near 3yr-low on 1/5 and China’s AAA/sovereign spread compressed -27bps last week to an 11-month low of 146bps wide.

 

China, With Context - 7

 

To further that point, the two major lessons from the ‘08/09 turn which are a relevant guide for today’s uncertainly are: a) commodities aren’t priced in the vacuum of Chinese demand (the rest of Asia, Europe, and the U.S. matter alongside the USD’s market value); and b) buying commodities ahead of/on the first Chinese rate cut proved to be a bad idea. To that tune, the CRB Index bottomed nearly six months and -41.3% after China’s first rate cut in early SEP ’08.

 

China, With Context - 8

 

Additionally, it’s important to understand that gross domestic capital formation is nearly half of Chinese GDP growth, which essentially means that investing in property has been the #1 driver of Chinese economic growth – not exports, consumption, nor government spending. On this front, China has pledged as recently as DEC to “unswervingly implement real estate curbs” in 2012. And as long as China’s property market is under siege, so will Chinese demand for raw materials (for construction, etc.).

 

China, With Context - 9

 

On the flip side of this view, Zhang Xiaoqiang, Vice Chairman of China’s National Development and Reform Commission, did say that Chinese policymakers plan to actively expand imports in 2012 via lowering import taxes for some raw materials and energy products. On the margin, finding clever ways of lowering the cost of such imports is bullish for Chinese demand. Moreover, Zhang said the 8-plus percent gain in CNY/USD since its de-pegging in JUN ’10 will “continue for a certain period”. That said, however, getting the timing right regarding an actual reacceleration in Chinese physical demand for raw materials will be of utmost importance here.

 

As of now, the data is not particularly supportive for China to meaningfully ease monetary policy in the near term. Moreover, inflation expectations need to continue trending down for Chinese assets to keep working and we anticipate that will happen as King Dollar continues to weigh on commodity prices over the intermediate-term TREND.

 

Darius Dale

Senior Analyst


WEN – HITTING THE BURGERS HARD IN 2012

TRADE: While the new burgers continues to help lift same-store sales trends, the combination of beef inflation and lower long-term guidance limits the current upside going into the company analyst meeting on January 30th. 

 

TREND:  We are cautious on this duration as rival brands continue to execute on their own remodel strategy.  CEO Emil Brolick has admitted that, while menu innovation is important, the full benefit won’t come through until the asset base is upgraded.

 

TAIL: We view the return of Emil Brolick as a boost to the long term prospects of the Wendy’s brand.  The company is still 6 months or so away from communicating lessons from the new remodel testing initiative. 

 

Grub Grade featured a story on the new Wendy’s burger being tested in select markets: a “Black Label” burger available in Bacon Portabella and Spicy Santa Fe varieties.  Here is a link to the article describing the product.

 

As we see the strategy from WEN unfolding, they want to keep the momentum from the new burger launch going.  The Wendy’s brand is a premium brand competing against the upstart burger chains like Smashburger and Five Guy’s.  Adding a premium burger with a higher price point will help to tier the menu and give customers another premium alternative.

 

The premium product has been in development prior to the Emil Brolick taking over as CEO but, we understand, the new burger was made a priority.  To us, that speaks to Brolick’s intention to focus on menu innovation to improve the image and broaden the appeal of the Wendy’s brand. 

 

The company’s first Investor Day since Brolick took over as CEO is scheduled for January 30th.  We believe the overall tone of the meeting will be positive but believe that the bar for EBITDA growth should be set slightly lower.  Additionally, expectations around the breakfast opportunity need to be reset lower also.  There are some difficult headwinds facing Wendy’s in the breakfast day part and we think they will take some time to resolve.

 

WEN – HITTING THE BURGERS HARD IN 2012 - wen1

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 

 

 


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